CITE AQ · CITE AQ ALLOCATOR QUARTERLY Q3 2018. THE SOUTH EAST EUROPEAN ECONOMIES. SEE economies are expected to continue to stand out in terms of maintaining their above average

CITE AQA L L O C A T O R Q U A R T E R L Y Q 3 2 0 1 8

THE SOUTH EAST EUROPEAN ECONOMIESSEE economies are expected to continue to stand out in terms of maintaining their above average growth rate for the medium term. Investors seeking to benefit from the strong eco-nomic cycle in the region may wish to consider real estate as a means to gain exposure to these buoyant economies.

TIM NORMAN : A PROPERTYPRACTITIONER’S PERSPECTIVE

Tim Norman of Chayton Capital talks about the current investment climate for real estate, strong fundamentals and the recent pickup in real estate investment activity. He believes there has never been a better time for active investment management in the region.

SUSTAINABILITY IN REAL ESTATE: SOUTH EASTERN EUROPE

With South Eastern Europe being a region where energy security is a geopolitical concern, the potential gains from focusing on building more sustainably in new construc-tion are immense. Partnering with developers who are experienced in energy efficient building techniques is key.

2 | CITE Allocator Quarterly

This AQ focuses on issues in and around investing in South East European real estate as a means of gaining exposure

to strong regional economic growth.

CONTENTOF THE QUARTER

NOTE FROM THE CIO 03THE SEE GENERAL ECONOMY 04

TIM NORMAN : A PROPERTY PRACTITIONER’S PERSPECTIVE 10SUSTAINABILITY IN REAL ESTATE: SOUTH EASTERN EUROPE 18

DISCLAIMER 24

Cover: Romania Bram Castle: Emily Marie Wilson / Shutterstock.com

3CITE AQ Q3 2018 |

NOTE FROM THE CIOThe world’s attention has been recently captivated with developments coming out of the US, with the Trump administration resurrecting protectionist trade policies in the face of two decades of in-creasing globalization. In Europe, Brexit has been the UK’s response to similar societal issues result-ing from increased inequalities brought on by glo-balized business value chains. Much ink has been used in the last few quarters to discuss if and how the UK will leave the EU in a few months’ time.

In the meantime, global growth has returned in force, with European growth also strong in the last 12 months. The quantitative easing measures are being withdrawn in the US, and are also in pro-cess of being scaled back by the ECB in Europe. In the UK, the BOE has equally begun raising interest rates, to combat inflation, which hit 2.3% in July this year.

As the world economy slowly re-adjusts to life post quantitative easing, investors may re-assess their expectations of growth in developed mar-kets going forward, with stock market valuations being close to their historical peaks.

While real estate in the developed markets has been a popular investment choice for many in-stitutional investors in the last few years, aided by the historically low interest rate environment, some markets have not yet benefited from the wave of investment that the global real estate as-set class has absorbed since the GFC.

We have recently been looking at the South East European economies, where the real estate as-set class, specifically, still offers healthy yield lev-els to those investors seeking to benefit from the strength of regional economies.

ANJELIKA KLAMPManaging Director

We note that the economies of South Eastern Eu-rope, with Romania and Bulgaria being prime ex-amples, have performed strongly in the last two years, and are expected by the EBRD to continue topping the European GDP growth tables in the medium term.

We take a bird’s eye view of the macro picture in the region, as well as some of the micro factors re-lated to reforms and government measures that have been contributing to the strong economic environment in the region.

We also include an interview with a real estate industry veteran, Tim Norman, who has been in-vesting in the Central, Eastern and South Eastern Europe for decades. Tim offers a practitioner’s perspective to investing in real estate in the re-gion and his views on the recent industry develop-ments.

Finally, we take a closer look at the sustainability angle of investing in real estate in South Eastern Europe. With sustainability being high on the agenda of many professional investors, we be-lieve that pioneering sustainable development in a region which does not have a history of sustain-able construction, is absolutely critical in achiev-ing investments that should not only provide solid IRRs to investors, but also make a positive impact on local communities.

We look forward to hearing from many of you if you would like to hear more on any of these top-ics, and if they resonate with your organizations.With warm regards from the team,


THESEE GENERAL

ECONOMY

An uptick in global trade has been a significant contribu-tor to the increase in global growth, with investment also on the rise, especially through investment recovery in de-veloped markets.

Developed markets’ central banks have begun to roll back the huge quantitative easing programs of the last few years, with the US leading the way. The Fed has increased interest rates three times since last Autumn to a level of 2%, and the quantitative easing, although still in place in Europe until end of year 2018, is being scaled back since June this year2.

Stock markets in the US are sky high, matching PE ratios from the 1920s, and PE ratios remain high throughout the world3. Just as global growth seems to still maintain mo-mentum, with the IMF April 2018 forecasts for 2018-2019 at 3.9% on average, market volatility has picked up in Feb-ruary 2018 and throughout the summer, spurred on by prospects of outright trade wars between the US and the

Global growth returned in force in 2017, with the world economy growing at an average rate of 3.8% last year, the fastest rate of growth since 2011.

rest of the world. The most recent focus on Turkey, with the US imposing tariffs on Turkish steel and aluminium, has sent the currency tumbling, and investors wonder about risks of contagion to the broad European region.

However, the current consensus seems to be that Turkey is unlikely to cause any significant effects on the Euro-pean financial system4, given that European banks have limited exposure in Turkey, Turkey does not rank par-ticularly highly for European exports and any outstand-ing concerns are more likely to be geopolitical, with the handling of the refugee crisis topping the priorities list.

In the current conditions, GDP growth in the European region continues to be on track with the interim summer forecasts by the European Commission5 being at 2.1% for 2018 and 2% for 2019 for both EU and Eurozone areas.

The South East European economies are expected to con-tinue to stand out in terms of maintaining their above

1. IMF, World Economic Outlook, April 20182. https://www.theguardian.com/business/2018/jun/14/ecb-calls-halt-to-quanti-

tative-easing-despite-soft-euro

3. EBRD, Regional Economic Prospects, May 20184. https://www.schwab.com/resource-center/insights/content/market-perspective 5. European Commission, European Economic Forecast, Summer 2018

Reduction in public debt to GDP since thepeak year (% of GDP)


average growth rate for the medium term, with Romania’s and Bulgaria’s economies expected to grow at 4.6% and 3.6% respectively in 2018, and 4.2% and 3.4% in 20193. This follows on from significant growth surprises of 2017, where Romania’s and Bulgaria’s real GDPs grew at a rate of 6.9% and 3.6% respectively.

Any investors who have been following the SEE economies over the last couple of years, will acknowledge that, despite concerns regarding a signifi-cant amount of the recent growth being generated by consumption rath-er than investment, the balance of economic indicators such as inflation, unemployment, public debt levels, currency stability and NPL ratios in the banking sector are favourable. Also, the European Commission’s own fore-casts and observations have been that more recently the rate of absorption of EU funds directed towards public projects has increased in the region, and they expect this to be maintained going forward.

Romania’s and Bulgaria’s economies are expected

to grow at 4.6% and 3.6% respectively in

2018, and 4.2% and 3.4% in 2019, following on

from significant growth surprises of 2017.

Source: AMECO, Erste Group Research, Fiscal and Debt Trends, June 2018

Previous page: Sofia: Kanuman / Shutterstock.comLeft: Belgrade Christmas lights: Milos Dumic / Shutterstock.comRight: Bucharest Calea Victoriei: Razvan Ionut Dragomirescu / Shutterstock.com

7CITE AQ Q3 2018 |

It is undeniable that the economies of the SEE stand in much better stead than when the Global Financial Crisis hit a few years ago. Unemployment is close to the lowest it has been since 2008 (with latest reading at 4.6% in Romania and 5.7% in Bulgaria6).

Public debt levels are at significantly lower levels relative to Western European economies, with Romania’s levels below 40% compared to the EU current average of 88.8%7. Also, over the last few years, Romania has managed to reduce this per-centage by around 4% through increased GDP growth. Certainly, there are some concerns that these debt levels might creep up, if Ro-mania does not reign in its deficit-as-percentage-of-GDP levels, as it only narrowly escaped the EC’s Excessive Deficit Procedure (EDP) in 2017. It has benefited from a low interest rate environment since 2010, which reduced the implied interest rate on public debt by 284bps over the period7. It has also been argued that the combination of the lack of public investment in recent years with priority being given to consumption, and the ultra-loose fiscal policy, the Romanian government may struggle to balance the books going forward. This may especially become true once the new EU spending budget is established for the period 2021-2027, where EU funding for SEE projects may be reduced and therefore relying on the EU as a sole source of funding for public investment will no longer be an option. At this point EIB, EBRD and the IMF could step in to fill part of the investment shortfall, but of course the Romanian government should not rely on this happening.

However, corporate debt in Romania is unchanged relative to its 2007 levels and at around 25% of GDP is at among the lowest in the EBRD region8. With less than 20% of it denominated in hard currency, Romania’s hard currency corporate debt exposure is well below EBRD averages.

6. https://www.ceicdata.com/en/indicator/romania/unemployment-rate 7. Erste Group Research, CEE Research, Fiscal and Debt Trends, June 20188. EBRD, Regional Economic Prospects, May 2018

Corporate Debt as a Percentage of GDP

Source: CEIC, national authorities, World Bank, IMF, OECD, BIS (assembled by EBRD)


Also, in the medium term the absorption rate of EU grants9 for infra-structure projects from the current EU budget has improved in both Romania and Bulgaria, which has been a positive contributor to GDP growth in both countries. Finally, Serbia will begin to fully benefit from EU funding, once it accedes.

Inflation pressures have picked up in Romania recently spurred on by last year’s public sector wage increases, which fed through to increases in petrol and food prices. To control this, Romania’s central bank has begun to raise interest rates with a series of hikes this year, resulting in a local currency base rate of 2.5%10.

Finally, SEE currencies have in the last few years shown very low volatil-ity relative to past history, as well as compared to major western cur-rencies such as the GBP, partly because of the long-term convergence objectives with the EU.

Against the backdrop of this improved macro environment, and after years of credit contraction post GFC, domestic banks have restarted to increase their lending to households and businesses11, which we expect will continue to support the local property markets. Local NPL ratios are among the lowest in the EBRD region11 and on average across the SEE region they are at less than half of their 2014 levels.

A significant increase in prosperity12 relative to the 1990s with PPP-ad-justed GDP per capita levels gradually converging with those of Western Europe13, tight labour markets and attractive taxation regimes with in-come tax rates as low as 10% in some SEE markets14 (Bulgaria) have all served to create an environment to support the government’s drive to reverse migration and improve the local demographic equation.

Increasingly a destination of choice for high tech outsourcing, with their high education levels of the local population, competitive wage levels and friendly tax regimes, Roma-nia and Bulgaria top the global outsourcing rankings.

9. European Commission, European Economic Forecast, Summer 201810. https://www.ceicdata.com/en/indicator/romania/policy-rate11. EBRD, CESEE region sees steady progress in bank lending, improving access to finance and NPL

resolution, new Vienna Initiative publications show, November 201712. Legatum Prosperity Index, https://www.prosperity.com/feed/regional-analysis-europe 13. World Bank Data, https://data.worldbank.org/indicator/NY.GDP.PCAP.PP.CD 14. Colliers, CEE Labour Force Boomerang, July 2017

9CITE AQ Q3 2018 |

Policies to attract emigres to return to their home countries have been targeted at those who wish to start businesses14, or those in need of training. Also, policies to promote mortgage lending to sup-port new home ownership and new construction to replace the ob-solescent communist-era housing stock have been put in place, such as the many iterations of the Prima Casa lending guarantee program in Romania15, as well as the lower rate of VAT on affordable homes under EUR 90,000.

Commitment to reforms to boost productivity and strengthen insti-tutions, such as the reform of the judiciary in Romania post EU ac-cession16, has provided support to the business environment. The long-term goal of convergence with the EU indicates continued di-rection of travel to higher levels of institutional integrity and trans-parency throughout the region. Despite the recent hiccups with the Romanian government trying to reverse the anti-corruption drive of the National Anticorruption Directorate, the wave of street protests that resulted from this demonstrates the strength of public opinion against corruption at all levels.

These priorities to improve business environment have certainly been heard and well received by the global business community. Increasingly a destination of choice for high tech outsourcing, with their high education levels of the local population, competitive wage levels and friendly tax regimes, Romania and Bulgaria top the global outsourcing rankings. SEE countries provide a home to many global blue-chip and high-tech companies, including amongst others Or-acle, Siemens, Bosch, Amazon, HP and Huawei. It is worthwhile to mention that these countries do not just provide outsourcing so-lutions for simple, labour intensive elements of global production chains, the level of complexity handled in the BPO sector in the SEE region is of the highest order17, using highly qualified multi-lingual technical and IT personnel.

Of course, the strong economic growth momentum of the last cou-ple of years has not gone unnoticed with investors, especially on the real estate side. Prime yields have been showing signs of com-pression18 from their depressed levels of post GFC period. However, while a number of large high-profile transactions have been highly publicized in the last two years, yields on other assets are still at very attractive levels, and there are still plenty of opportunities in vari-ous segments for those investors seeking to gain exposure to these buoyant economies.

15. European Commission, European Construction Sector Observatory, Country Profile Romania, June 2018

16. IMF, Reforming the Judiciary: Learning from the Experience of Central, Eastern, and South East-ern Europe, Chapter 2

17. Colliers, A thoroughbred racer, November 201718. Colliers, The CEE Investment scene – H1 2018 CEE flows and drivers

Top: Romania Timisoara: Veronika Kovalenko / Shutterstock.comBottom: Sofia new construction (reflection of old building): Petia Miladinova / Shutterstock.com


TIM NORMAN : A PROPERTY PRACTITIONER’S PERSPECTIVE

The last big cycle of real estate investment in Central, Eastern and South Eastern Europe passed like a tidal wave, peaking in 2008/2009, and retreating abruptly in the aftermath of the GFC. With liquidity completely disappearing for a num-ber of years subsequently to the GFC, many funds and AIM listed companies had to close amid large capital losses and the managers were swept under never to resurface in the region again. Those who survived have accumulated years of experience in investing in the region, dealing with local bureaucracy, and have learnt from the past ups and downs to come out more resilient.

Tim Norman of Chayton Capital1 is one such veteran inves-tor. Today, Tim talks about the current investment climate in the region, political uncertainty with recent demonstra-tions, strong fundamentals and the recent pick up in activ-ity with some global institutions returning selectively to the market. He believes there has never been a better time for active management, in a market that is strongly supported by robust economic growth, but is still immature relative to Western European property markets.

Investing in Property in South Eastern Europe: A Practitioner’s perspective

Tim Norman is a Managing Partner at Chayton Capital LLP. Before Chayton, Tim invested in Eastern European real estate at Europa Capital, prior to which he spent a number of years at EBRD, in their property banking team. Over his career Tim has experienced many aspects of investing in real estate in the SEE region, and has done a mul-titude of deals of various types, from hospitality to offices, from logistics to residential. 1. Chayton Capital LLP are a UK based partnership, FCA regulated, and specializing in

investing in Central and South East European property markets.

11CITE AQ Q3 2018 |

Q: The SEE countries have benefited from strong growth in re-cent years, even in some instances, like Romania, delivering growth surprises last year, 2017. This has been accompanied with positive data along the other macro variables such as low unemployment, relatively low inflation, stable exchange rates against the Euro, and solid consumption. Local govern-ments, particularly in Romania have in the last few years put an increased focus on improving the integrity and transpar-ency of their institutions, as well as attracting emigrants to return and solidify the local labour market with skills gained abroad. Yet recently we have seen in Bucharest a wave of sig-nificant protests against corruption demanding the resigna-tion of the government, with some of the participants being from the Romanian diaspora living abroad. Should potential investors be worried of further civil unrest and disruptions to the trajectory of Romanian economy?

A: The recent events in Romania reflect the very active view that the Romanian electorate take in participating in the gov-ernment of their country. This is also true of the diaspora, as they were the key factor in the outcome of the last presiden-tial election in 2014, which saw Klaus Iohannis of the Chris-tian-Liberal Alliance take the presidency and replace Băsescu and Ponta, who had to step down at the time amid corrup-tion controversy.

The Romanian people have always been very pro-active in using their democratic right to protest against corruption in government and assert their desire to clean up institutions. About 20 months ago 300,000 came out to protest against the plans to water down policies to combat corruption, with smaller demonstrations following in November and Decem-ber 2017.

Source: Belgrade roofs: Nataliya Nazarova / Shutterstock.com


In the recent months, emergency measures were put through parliament to enable some watered down anti-corruption policies to pass. Equally, the president was forced by the constitutional court to sack the Head of the National Anti-corruption Directorate (DNA), Laura Kovesi, who was award-ed in 2016 France’s Légion d’honneur for her anti-corruption work. This is the last class of politicians in Romania who are considered to be corrupt by the Romanian public, and who are unlikely to get re-elected. As the popular demonstrations in reaction to these events have shown, corruption or any indication that anti-corruption measures are being watered down, are hugely unpopular at all levels of the Romanian so-ciety.

Last Friday night, violence was used for first time ever since the Romanian revolution of 1989 and Ceaușescu’s demise. Is-raeli tourists and an Austrian photographer were beaten up

“…with the support of the EU behind it, [this is an opportunity] for the Romanian people to ef-fect the greatest social

and cultural changes that we are to witness at

this moment in time in Europe.”

by the police amid violence against the demonstrators. Both governments of Israel and Austria have lodged complaints with the Romanian gendarmes, along with a number of civil complaints from Romanian citizens against police brutality.

These events were followed on Saturday by a larger passive demonstration to protest against the police brutality of the night before, and affirm the Romanian people’s resolve to defend their democracy.

I am convinced that while the headlines may appear nega-tive, this is an opportunity for Romania to turn a corner, and with the support of the EU behind it, for the Romanian people to effect the greatest social and cultural changes that we are to witness at this moment in time in Europe. These events are an integral part of the drive in the long term to get rid of corruption.

Q: How sustainable do you think is the GDP growth generally across the region?

A: EBRD’s most recent report shows that the growth rate of 3-5% is sustainable in the SEE region across the board. This is supported by the large amount of funds that the EU directs to the region, as well as the countries becoming more adept at absorbing the grants that are given by the EU. The rules around debt thresholds are quite complicated to navigate and some of these countries have had quite a high turnover of politicians which has meant that EU funds absorption has been slower than hoped. However, increasingly, governments are getting more organized, more used to the EU rules and see the real benefit that the EU fund-ing can bring.

Equally, investment from EU institutions is now also accompanied with a greater level of experience from the EU and other European institutions such as EBRD, EIB etc, as to how to successfully fund projects in the region. Their collective experience of lending in the CEE is now being successfully used and replicated in the SEE.Among other funders of projects in the region, EBRD is the single largest investor in every country in the SEE. EBRD investments tend to be commercial, made to entrepreneurs and private businesses, and which do not compromise state borrowing levels.

Other factors that I believe will continue to contribute to growth sustainability are the in-dependence of Central Banks in the region (which are supported by the ECB and protected from manipulation by local politicians), low state borrowing level and generally low income tax rates (eg 10% in Bulgaria). Many of these policies are really geared at trying to build and support business.

Source: Bucharest protests: Creative Lab / Shutterstock.com

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Q: How does real estate in the region compare to investment opportunities in other asset classes, for an investor who would like to benefit from the current regional growth environment?

A: With the local equity markets being fairly small and illiquid, private equity and real estate investments are valid avenues for investors to pursue if they would like to gain exposure to the strong fundamentals of regional economic growth.

A number of Central European based private equity investors such as Mid Europa invested in retail businesses (eg food retailers such as Profi, the largest supermar-ket chain in Romania, or pharmacies) in the region and have been successful in exiting with some of these transactions having turned out more profitable than investing in real estate over the same period.

Relative to this, real estate has had a bit of a lag. We have to recognize that real estate takes longer to recover than other parts of the economy, as it is at the end of a long-lead chain of the economy. Let us look at the example of automotive – it takes years to build a factory, which then can generate demand for supplying busi-nesses, and in turn will support a demand for real estate in light industrial and warehousing. This process will happen gradually and with a lag.

Similarly, some types of real estate have done better than others. For example, while offices and light industrials have recently grown, logistics outside Bucharest have lagged as it takes time to build up demand for inventories and warehouses. You have to remember that we are looking at the poorest part of the EU, with consumer demand increasing very strongly but from a low level. It will take a gen-eration to build up demand for similar stock of logistics space as what you have in Poland.

“We have to recognize that real estate takes

longer to recover than other parts of the

economy, as it is at the end of a long-lead

chain of the economy.”Source: Bucharest new construction: Cristian Balate / Shutterstock.com


Q: What types of risks do you consider to be prevalent in the region, and what should potential investors be aware of when considering real estate as an investment option to gain exposure in the region?

A: The market is still not very institutional nor is it ma-ture. There are a number of high quality advisors (law-yers and accountants) covering these markets, but there can still at times be a lack of transparency. Risks of deal-ing with local bureaucracy are a challenge. Investors have to be prepared to be diligent and patient in dealing with this, and make sure that they have enough inexpensive resources locally to deal with local bureaucracy. Also, any project in the region must have realistic timeframes to deal with any potential delays.

Local property markets are still relatively small, and as GFC showed liquidity can dry up. If you buy a large single asset, you automatically limit the number of potential buyers in case of a liquidity crunch.

Currency risk is fairly easily mitigated if you conduct your business in Euro, i.e. both your rent income and debt are denominated in Euro. But of course, Romania for ex-ample is quite an inflationary economy, and historically currency volatility used to be substantial which affected operating costs. However, in the last few years, the Ro-manian Leu has been relatively stable against the Euro.

Political risks are still present, eg Macedonia suffered from severe political crises in the past year. Current demonstrations in Romania are obviously the remnants of the legacy problem with corruption and as I said ear-lier, I believe them to be an opportunity rather than a throwback to the past. Obviously, EU accession and con-version plans for the region are mitigating any adverse events along the way and are ensuring a positive long-term trend.

“Currency risk is fairly easily mitigated if you conduct your business in Euro, i.e. both your rent income and debt are denominated in Euro.”

Source: Romania shopping mall: Radu Bercan / Shutterstock.com

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Q: Post GFC, we have witnessed a dearth of real estate in-vestment in CEE/SEE, with investment volumes only seeing a pick up since 2016. The majority of flows have favoured Central Europe, with Poland, Czech Republic and Hungary leading. Do you see a similar pick up in flows happening in the SEE region?

A: We saw a slight pickup in activity in the SEE property market last year, with a number of publicly listed South African PE firms investing over EUR 1bn just in shop-ping centres in Sofia alone, and many EUR100s millions in class A offices in Romania. This has been about flight capital out of South Africa, looking to invest in high-yield-ing assets.

There are only a few large class A assets left to buy both in Bucharest and Sofia at this point, and some of the South African investors have now moved their attention on to CEE and SEE generally. As such, we do not expect flows to increase further from last year’s levels. Large transactions should be down this year, but last year has certainly set a new base for transactions going forward in terms of overall volume.

Q: What kind of investor are currently attracted to the real estate in the region?

A: In addition to the South African PE firms mentioned, global direct investors (such as GLL, Morgan Stanley and Cerberus) have started to return to the region or some are looking at the region for the first time. Also, some regional firms are relatively active, such as the Czech company PPF Group, as well as more entrepreneurial investors from Turkey and Israel, who tend to be less in-stitutional.

Q: How do you see the recent events in Turkey impact in-vestment flows into the SEE region, if at all?

A: We believe that the recent events will encourage Turk-ish investors to leave their domestic market and look to the SEE for opportunities. Turkish investors have tradi-tionally liked real estate and are highly entrepreneur-ial. Investing in real estate in South Eastern Europe will provide them with much needed hard currency earn-ings. Turkish Lira has been a long-term soft currency, so shielding their investments in this way may be attractive.

Q: What kind of investors should look at the SEE property market closer? Who else could this asset class be for?

A: Any investor who want a higher return/yield than they can get in other markets should look at the SEE more closely. This could include smaller institutions who are more interested in looking at more entrepreneurial mar-kets and are willing to make a little more effort on due diligence, or alternatively outsource due diligence to a qualified party. Family offices and HNWIs who typically take a more entrepreneurial approach in their portfolio management could also find that the local market offers an attractive combination of solid yields, and a prospect of capital uplift.

Source: Romania Oradea: Catalin Lazar / Shutterstock.com


Q: What is the investment horizon you see as ap-propriate when considering real estate invest-ment in the SEE region?

A: Real estate is a long-term investment, but being mindful of the regional business cycle, an investor might consider shorter horizons, as well as the likelihood of discretionary funds entering the markets in the next few years. This would provide opportunities for exiting investments in due course, which is what we experienced in 2007-2008.

Pan-European property funds such as Europa Capital, Patron, Orion and Rockspring, have discretionary capital and could at some stage look at the region. Past examples of such mar-ket participants are the French group AEW, as well as Aberdeen who entered the market at some point with large amounts of commit-ted capital and provided liquidity and exit for smaller, more nimble investors.

Q: Do you consider that debt financing for the purpose of leverage is currently easily avail-able? What are the current conditions in the lending market?

A: Yes, I would say that debt financing condi-tions currently tend to favour the borrower. The wave of South African investment was financed mostly through capital markets, be-cause of the sheer size of the deals. Local lend-ers, such as Raiffeisen, Erste, UniCredit and the BNP-owned BRD in Romania, are under pressure to expand their lending books. For example, the financing on the recent Morgan Stanley deal for America House asset in Bucha-rest is one of the few deals which was financed through local branches of regional banks.

Q: You have spent over a decade investing in the region. What is your own perception of corrup-tion? How has this changed over the years? How do you handle it in your day-to-day approach?

Image: Bucharest modern offices: Creative Lab / Shutterstock.com

17CITE AQ Q3 2018 |

A: I believe there are two types of corruption in the region: one to do with individual transactions when it comes to building permits for high profile locations for example, which involves bribery at political level. The other is to do with operational corruption of interacting with post-communist bureaucracy.

To any investor contemplating entering the market, my strong recommendation is to steer clear of either of these. At Chayton for example, we deliberately pursue a strat-egy that avoids getting involved in the permitting process, or specifically for residential and retail development we typically like to get involved in stages post permitting, with the development risk being left to the developer to handle. For newly built assets, we typically operate on a pre-funding basis, where the developer keeps the risks and the rewards of the development risk, and we get involved in the later stages.

As far, as operational corruption goes, you have to make it very clear that you operate above board. You must have patience and determination, and enough inexpensive lo-cal resources to go through the bureaucratic processes at their pace. It may mean that time scales may have to be longer than elsewhere, but it is entirely possible to operate in these markets by the book.

Q: For an investor who are looking to benefit from the up-side potential of the currently strong economic environ-ment, while at the same time managing downside risk, what approach would you recommend, and how can ac-tive management help?

A: Our strategy is to invest in assets which benefit from strong consumer spending, but at the same time are re-silient in a downturn. In immature markets, a simple low-tech approach to real estate investing is what is needed. This means avoiding development risk as far as possible and aiming at assets with established tenants and cash-flow. Another idea is to tap into aspirational ambitions of younger population for better standard of accommo-dation than is available locally. And of course, a simple approach means focusing on population centres, mainly capital cities, and avoiding small rural locations. Capi-tal cities in the region continue to be fast growing with strong demand for residential. Outside capital cities, re-gional centres begin to emerge only later on, once the economy becomes more sophisticated (as was the case in Poland).

Active management in selecting the right assets and building an exit strategy is absolutely vital, as well as sourcing and managing good trustworthy local partners who will provide tenant management services etc.

Q: How would this change in a different type of environ-ment, eg if interest rates in Eurozone were to increase? How do you stay on top of this in your strategy?

A: European economies have been relatively stable in the recent past, despite hiccups in interaction of the EU with some of the CEE countries. Interest rates in Eurozone are not expected to increase rapidly, and therefore we do not see interest rates as a big risk to SEE real estate currently.

As an active manager in real estate, our challenge is to construct a resilient portfolio from the outset, as rebal-ancing at a later stage may be more complicated com-pared to other asset classes. We believe that we need to focus on assets that can be divested more quickly than other types of assets, either as a whole or in parts. And our approach is also to stay away from very specialist ar-eas or large single assets for which there would be only a limited number of purchasers.

This interview was conducted on August 14th, 2018 at CITE Investments’ offices at 1 Fore Street, London EC2Y 9DT.

“Active management in selecting the right assets and building an exit strategy is absolutely vital, as

well as sourcing and managing good trustworthy local partners who will provide tenant

management services etc.”


SUSTAINABILITY IN REAL ESTATE: SOUTH EASTERN EUROPE

Among the UN’s 17 Sustainability Development Goals1, a number relate to effi-cient use of resources and its impact on the environment around us, eg Affordable and Clean Energy, Sustainable Cities and Communities, Responsible Consumption and Production, and Climate Action. While some ambitious global goals can always be stated as lofty aspirations, these might be easier to embrace for High-income Countries compared to Middle- or Low-Income Countries where addressing con-cerns of meeting the public’s basic survival needs takes priority. It is also doubtful whether funding the changes required to make some of these SDGs a reality is equally accessible across all countries.

The role and the challenge of the bodies such as the European Commission is to formulate a unifying framework to help evaluate the current status of industry practices at EU level as well as translate the aspirations into concrete strategies and help fund them.

The general public, governments, as well as supra-national bodies such as the UN, are increasingly aware of the en-vironmental, economic and social impact of the world’s dependency on fossil fuels and finding ways to reduce our global consumption of fossil fuels has been an area of growing focus.

1. https://www.un.org/sustainabledevelopment/sustainable-development-goals/

19CITE AQ Q3 2018 |

Improving the energy ef-ficiency of existing build-ing stock, as well as com-

mitting to sustainable building methods in new

construction remains a huge challenge in the

region, with its “build-ing stock still consuming

38% of gas imports”.

Image: Bucharest old communist apartment block: douglasmack / Shutterstock.com


Further, the European Commission stress tests of 20142 identified Central and South Eastern Europe as a region where energy security is a major con-cern tied to geopolitical uncertainties. This means that addressing sustain-ability and energy efficiency on all lev-els in the region has gained in impor-tance in recent years.

To this effect, initiatives such as the Central and South-Eastern European Energy Connectivity3, the original CE-SEC, and CESEC 2.0 launched respec-tively in 2015 and 2017, as well as the set up of various funding streams such as the Cohesion Policy Funds (CPFs) and the European Fund for Strategic Investments (EFSI) are aimed at sup-porting the reduction of the region’s external energy dependency as well as at reducing overall energy consump-tion across the local economies4.

Significant headway has been made in terms of supply-side measures such as upgrading strategic energy infra-structure and integrating the regional energy markets to lessen external de-pendency, with the EBRD’s recent EUR 100mn investment into the Bulgarian Energy Holding EUR 550mn bond is-sue5 being another example of fund-ing sources available to support sup-ply-side infrastructure in the region. Meanwhile demand-side measures have lagged. Improving the energy effi-ciency of existing building stock, as well as committing to sustainable building methods in new construction remains a huge challenge in the region, with its “building stock still consuming 38% of gas imports”.

For example, according to the Euro-pean Commission’s “Guide on good practice in energy efficiency for Central

and South Eastern Europe”6 “in Roma-nia in 2015, residential was the biggest energy consuming sector, representing a 33.7% share in final energy consump-tion, which is well above the EU aver-age of 25.4%.”

The potential gains from improving energy efficiency of existing building stock, as well as using more sustainable building approaches in new construc-tion are immense. According to BPIE, “a dedicated renovation programme tar-geting gas-consuming buildings could reduce the current building stock’s gas consumption by 70% within 20 years”.

So what are the bottlenecks that are preventing these beneficial measures from being implemented? A closer look at the types and amounts of EU funding available for energy efficiency upgrades, as well as their interaction

2. European Commission, “Stress tests: cooperation key for coping with potential gas disruption”, October 2014 (https://ec.europa.eu/energy/sites/ener/files/documents/2014_stresstest_infographic_0.jpg)

3. Memorandum of understanding CESEC & CESEC 2.0 (https://ec.europa.eu/energy/sites/ener/files/documents/CESEC%20MoU_signatured.pdf) (https://www.energy-community.org/regionalinitiatives/CESEC.html)

Corporate Debt as a Percentage of GDP

Source: BPIE, Financing the future of buildings in Central, Eastern and South-East Europe, 2017)

21CITE AQ Q3 2018 |

with debt and deficit thresholds, reveals that the demand-side challenge is likely to remain largely unaddressed in the near term, unless significant private funding becomes available.

Indeed, while the overall amount of funding from the CPFs dedicated to energy efficiency in buildings in the CESEC region may sound significant (EUR 3.96bn over seven years), relative to the size of the building stock, the commitment translates into a rate of only EUR3.00 per square meter in Romania and significantly less elsewhere in the CESEC region. Also a number of countries in the region such as Slovakia choose to prioritize the upgrading of public buildings to the detriment of residential, which means that the vast majority of housing stock remains under-funded.

Part of the reason why countries under-use the potential funding available is that many opt for grant types of funding, which is non-repayable and does not impact on their debt and deficit levels, thereby limiting their risk of breaching EU debt and deficit thresholds. Thus, there is a crowding-out effect, with grants being preferred to the detriment of other financial instruments or loans that would otherwise po-tentially allow leverage of private funds and unlock much larger pools of capital.

Other types of funding, such as the EFSI (which is designed to leverage public fund-ing to unlock private funding through the multiplier effect), favour supply-side in-frastructure projects, and concentrate on more mature financial markets in the EU, with only 1.25% of committed funding being allocated to projects in the CESEC region.

4. BPIE, “Financing the future of buildings in Central, Eastern and South-East Europe”, 2017 (http://bpie.eu/publication/financing-the-future-of-buildings-in-central-eastern-and-south-east-europe/)

5. Mario Tanev, “EBRD invests 100 mln euro in Bulgaria’s BEH 7-yr bond”, August 2018 (https://seenews.com/news/ebrd-invests-100-mln-euro-in-bulgarias-beh-7-yr-bond-622495)6. European Commission, “Guide on good practice in energy efficiency for Central and South Eastern Europe, June 2018 6.(https://ec.europa.eu/easme/en/news/new-guide-good-

practice-energy-efficiency-central-and-south-eastern-europe)

Intended form of Finance

Source: BPIE, Financing the future of buildings in Central, Eastern and South-East Europe, 2017

FLOOD EARTHQUAKE

Annual average affected population

Annual average affected GDP (million US$)

Annual average affected population

Annual average affected GDP (million US$)

Baltic States 800,000 9,000 50,000 600

Caucasus States 300,000 800 600,000 2,000

Central Asian States 1,000,000 4,000 2,000,000 5,000

European Union States 2,000,000 20,000 1,000,000 20,000

Russian Federation 2,000,000 20,000 200,000 1,000

South East European States 1,000,000 9,000 2,000,000 20,000


However, while funding remains the stumbling block to addressing the mass problem of energy efficiency and sustainable construction, on-the-ground initiatives funded by the EU continue to create Building Knowledge Hubs and train the local building community in sustain-able building techniques. This creates a building trade workforce, capable of implementing Nearly Zero-Energy Building (nZEB) projects and deep energy renovations of existing buildings in Central and SEE region, available to carry out such projects as funding continues to increase.

Focusing solely on the energy efficiency side of the real estate sustainability equation ignores other aspects criti-cal to sustainability in a region that is periodically affect-ed by earthquakes of varying severity.

No building sustainability discussion of the CESEC is com-plete without acknowledging that building practices in the region have historically lagged in terms of delivering structures resilient to earthquakes, and in some coun-tries enforcement against non-compliant construction has only just started to be used as a measure to compel developers to build responsibly. As a result, some coun-tries are more vulnerable than others to a risk of loss of life and a significant GDP impact if a severe earthquake event occurs.

Based on historical data7, estimates of capital loss from a severe earthquake can be as high as $20bn (or 11% of the country’s GDP) in Romania or $4bn (or 8% of the country’s GDP in Bulgaria). Country governments have been under pressure to step up their efforts to ensure a working legal framework to earthquake proof new construction.

According to Georgescu et al8, in Romania, 69% of build-ings in existence in 2011 were constructed before 1977, meaning that they do not have adequate earthquake resistance. The current building stock uses three main building techniques, the cast-in-place RC shear wall struc-tures (pre-dominant in seismically sensitive zones, and whose performance is good or fair in case of a seismic event), and the old and new RC framed structures (the latter, with regular column patterns, performing signifi-cantly better in a seismic event). Post 1977 earthquake, only local repairs were carried out on surviving struc-tures, which meant that a large number of damaged resi-dential high-rises with high occupancy is at high risk from future seismic events.

The “seismic design codes P100-1991, revised in 1992 and 1997, introduced in chapters 11 and 12 the obliga-tion to evaluate buildings and indicate classes of risk […]”8, with buildings of first class of risk being labelled in red”. Later Code P100-2008 dictated that “evaluation of residential buildings resistance was provided for free”8, with strengthening work potentially qualifying for a 5% 20-year loan, or in some cases of first class risk apart-ments the remedial work being fully subsidised if the owner’s income is below national average.

Various strengthening techniques for existing buildings have been specified depending on the age of the build-ing and the techniques used in constructing it in the first place. These techniques include general jacketing of ex-isting frames or frame bracing (which alleviates the need for evacuation).

7. World Bank Group/ GFDRR, “Europe and Central Asia - Country Risk Profiles for Floods and Earthquakes”, May 2016 (http://www.worldbank.org/en/region/eca/publi-cation/europe-and-central-asia-country-risk-profiles-for-floods-and-earthquakes)

8. Georgescu et al., Seismic and Energy Renovation. A Review of the Design Approach in Italy and in Romania, Sustainability, May 2018

Source: World Bank Group/ GFDRR, Europe and Central Asia - Country Risk Profiles for Floods and Earthquakes, May 2016

Annual Average Affected Population and GDP

23CITE AQ Q3 2018 |

One way to ensure that the right developer is used locally, is for investors to appoint an investment man-ager with local market knowledge and links...

New construction fairs significantly better on sustainabil-ity, both in terms of energy efficiency, and earthquake re-sistance. In Romania, for example, since 2007 an energy performance certificate is compulsory for all new builds, as well as on refurbished buildings. There has also been a new edition to the seismic design code in 2012, enforced from 2014, which further upgrades building standards.

What does all of this mean for investors who are con-scious of sustainability issues and who would like to ben-efit from a strong local economic environment by invest-ing in real estate in the region? For one, investors must understand that they will bring much needed financing to all types of real estate projects, with demand particularly strong for affordable residential (both to purchase and to rent, which is a developing trend in these markets). Both

Romania and Bulgaria, for example, have large and grow-ing urban populations and suffer from overcrowding in old style building stock.

And of course, investors must be aware of the risks asso-ciated with choosing the wrong local development part-ner. Increasingly, the local construction community is conscious of the new regulations, and investor expecta-tions with regards to compliance with building standards. However, the risk of a cowboy developer lurks in the background. One way to ensure that the right developer is used locally, is for investors to appoint an investment manager with local market knowledge and links, who are able to select developers with experience in using the lat-est available building techniques, and who make sustain-able construction methods a priority.

Image: Sofia skyscraper: tishomir / Shutterstock.com

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